spRING 2011 GlobAl MARKETs INTERNATIoNAl - Willis

PolItICal rIsks
iNtRoduCtioN
The Mining industry is quite possibly one
of the most vulnerable to Political Risks in
Emerging markets. Due to its importance
to host economies – mining projects can
potentially represent over 10% of GDP in the
country of production – these projects can
easily become flash points for nationalist
debate and a change in government policy
that can lead to expropriations, licence
cancellations and contract ‘reviews’.
With commodity prices expected to remain
robust, more mining companies see their
future inextricably linked to Africa, Eastern
Europe, Latin America, Southeast Asia and
other ‘new frontier’ regions. As a result, the
words ‘political risk’ are rolling off the tongues
of mining executives and lenders with ever
more frequency. Companies need to conduct
a comprehensive assessment of their political
risk and take steps to adequately mitigate
these risks.
| Willis | Mining Market Review 2011
Risks to MiNiNg CoMPaNies
Traditionally, political risk has meant risks created by the action or
inaction of governments, such as expropriation. However, national
governments are no longer the only, or in many cases, the primary
source of political risk for mining projects. Political risk can also stem
from local governments, international and local NGO’s, community
groups, local competitors or any other group advancing political
objectives. Likewise, rather than an outright confiscation of a foreign
investor’s assets, investors are more likely to witness a more indirect
form of government intervention known as ‘creeping expropriation’.
This refers to state conduct that substantially deprives a foreign
investor of the use or benefit of their investments, even though
formal legal title may continue to be vested with the investor.
Such expropriation could take the form of the imposition of a punitive
tax regime that is applied selectively against the foreign enterprise and
which is not applied to local companies. Indeed, taxes and royalties in
the Mining sector have become a major issue.
In 2006, the Mongolian government hastily passed a windfall profits
tax. This was designed to allow the state to benefit from historically
high copper and gold prices, but instead, set the stage for acrimonious
negotiations with the Oyu Tolgoi developer, Ivanhoe Mines Ltd of
Canada. Fears that the Mongolian state would lose out on the benefits
from the USD 4billion Oyu Tolgoi project led the government in 2006
to pass a law requiring the state to take 34% of any deposit.
Debates over the state share and the windfall profits tax followed,
throwing investors into a state of uncertainty and freezing projects
during the peak of the commodity boom. The windfall profits tax did
not apply to ore smelted in Mongolia, but Ivanhoe argued that building
a smelter would raise its capital and investment costs prohibitively.
The windfall profits law assessed a 68% tax on copper above USD
2,600 a tonne and gold above USD 500 an ounce. Ivanhoe’s partner
Rio Tinto, and the Mongolian government, have since reached an
agreement and under the current proposal, the windfall profit tax will
be abolished on 1 January 2011. Under the new deal the government
gets a flat 34% stake in the Oyu Tolgoi project and other mines. It
can raise that share by 50% after 30 years once the two miners have
recouped their initial investment of USD 4billion. This change in
political priorities, however, only came about following the election
of the Mongolian People’s Revolutionary Party which then placed
a higher priority on developing Mongolia’s mineral resources and
reopening negotiations with Ivanhoe and Rio Tinto.